Housing Starts, and Fits

By

Robin Goldwyn Blumenthal

Updated Oct. 16, 2000 12:01 a.m. ET

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T he stock market may have created unprecedented riches in recent years, but for the majority of individual investors, home is still where the heart, and most of their wealth, resides. And, just as stock indexes have skidded from their highs, housing markets in some key areas around the country also may have peaked.

No doubt the longest-running economic expansion in history that has helped the market soar has also lifted home prices to record levels. From 1995 to 1998, the most recent data available, the value of primary residences climbed 20% to $9.4 trillion, while the value of stocks owned by households nearly doubled, to $7.4 trillion, according to a recent report by the Joint Center for Housing Studies of Harvard University. But though stocks in aggregate have surpassed home equity as a share of total household wealth, 59% of homeowners with stock holdings still had more equity in their homes than in stocks in 1998, the Harvard report shows.

"We've had a 10-year economic expansion, and a rising tide lifts all boats," says David Lereah, chief economist of the National Association of Realtors. "Every region has participated in record-setting housing over the past three years." But the rise in mortgage rates -- to just under 8% for 30-year conventional loans, about a percentage point above their lows of late 1998 -- and the steep appreciation of home prices may have finally made an impression on national housing trends.

"After eight years without a significant correction ... the housing expansion is poised for a slowdown," the Harvard report asserts. Indeed, recent statistics from the realtors' group and the National Association of Home Builders suggest a shift in the market.

The realtors' housing affordability index, which factors in family income, home prices and interest rates, plunged to an eight-year low in June, when new-home sales also fell to a two-year low. Though existing-home sales rose sharply in August, climbing 9.3%, month-over-month, after a 9.2% drop in July, August sales were still down 0.8% from the year-ago month. "When you combine interest rates and price appreciation, you end up pushing affordability down," says Lereah. Though he believes price appreciation is still "relatively strong," he acknowledges that it could be easing somewhat. "The volatility in the stock market and the correction we've had over the past several months has changed investors' portfolio decisions," Lereah says.

Another indication that the housing market may have peaked is the home builders' housing opportunity index, which experienced "a drastic decline" in the second quarter from the first, says Gopal Ahluwalia, director of research at the National Association of Homebuilders. The index, which measures how readily the median-income family can afford homes that actually sold in a region, fell to its lowest level in seven years owing to rising rates and prices. That should augur flattening prices, Ahluwalia says. He predicts prices will stabilize.

Though home prices have continued their seemingly inexorable rise in the past six or seven years, to a national median price of $143,300 for existing homes in July -- the highest on record -- they aren't by themselves always reliable indicators of market trends. Indeed, the median sale price of existing homes fell back in August to $142,200, indicating "the housing sector has plateaued," according to Merrill Lynch economist Karen Dexter.

But national trends tell only part of the story. All real estate, like all politics, is local. As in previous years, Barron's turns again to Ingo Winzer, president of the Local Market Monitor in Wellesley, Massachusetts, for an indicator called the equilibrium home price -- a gauge of whether actual home prices in a given market are out of balance with underlying economic conditions. This kind of value-oriented lens seems especially useful now, because it suggests areas that may be due for a bust, as well as those that are undervalued.

"People think there aren't speculative bubbles anymore, but there are," Winzer says. "When I started this 10 years ago, I wasn't really sure whether it was going to prove out. But now you look at it, it's really proven to be a pretty good guide." Indeed, some of the priciest areas on the East and West Coasts, such as San Francisco or New York, provide evidence that housing, like the stock market, moves in cycles. And, because Winzer says that residential real estate tends to lag economic development of a local market, "If you see a market where jobs are being lost or growth has flattened, you don't see the effect in flat or lower real estate prices for a year or two," he explains.

For example, he notes that the California markets are going through a second boom, similar to that of the late 1980s. But actual home prices in Orange County, California, for example, peaked in 1990, but eventually came back into balance with the equilibrium price in the mid-1990s, after the economy absorbed the shock of the defense industry's collapse. And areas like West Palm Beach, Florida, which were undervalued but experiencing good economic growth when Barron's last looked at Winzer's equilibrium prices in 1997, have come back into equilibrium. Then-hot spots like Portland, Oregon, have cooled, though remain overvalued, while Seattle, which was 15% overvalued in 1997, has come back down to earth.

By Winzer's calculation, as of the second quarter, Orange County was 18% overpriced. Salinas, 75 miles south of San Francisco, was 41% overvalued, while San Francisco itself, fueled by the breathtaking rise in Internet investment, was 28% overpriced.

But while housing prices in the Bay Area ran up 26% in the second quarter from the year-earlier quarter, Tom McManus, equity strategist at Bank of America, notes that hefty real-estate returns still pale relative to the S&P 500's return of 18% a year for the past 10 and 20 years. "There are very few real-estate investors that have done as well," he says.

Though median home prices in California hit a record $255,580 in August, up 14% from a year earlier, Winzer notes, "When a market shoots up above the equilibrium price, at some point prices have to converge." Prices tend to level off for a while before falling. Though he predicts a correction in California home prices should be less severe than the 25% drubbing seen in some areas in the 1991 recession, he expects prices to start flattening out as soon as next year. Indeed, according to the California Association of Realtors, the median price of a single-family home in San Francisco fell 1.2% in August from July, to a still hefty $454,470. "A continued shakeout in the IPO and venture-capital markets would be meaningful in California," writes G.U. Krueger, deputy chief economist of the California realtors' group. But Krueger points out that the $25 billion in start-up and IPO financing received in 1999 was far less than the $46 billion in 1999 dollars of prime defense contracts the state received at its peak in 1984-1985. That, however, does not take into account the massive wealth created -- and more recently destroyed -- on the Nasdaq.

Still, the regional economy isn't the only determinant for prices, as New York City's market demonstrates. As Winzer observes, some markets, like New York and California, always command a premium price over Middle America, for which the equilibrium price adjusts. Other things, like population growth, come into play. For instance, a relatively prosperous market like Columbus, Ohio, where the population holds fairly steady, tends to have a predictable increase in home prices that tracks the local economic trends.

In New York City, where there's been "a tremendous demand that's not being met by current supply," average sales prices skyrocketed 42% in the second quarter from a year earlier quarter, to $854,704, according to Jonathan Miller, president of appraisal firm Miller Samuel. Miller, whose firm writes the quarterly Douglas Elliman Manhattan Market Overview, notes that most of the new development has been in the very high end, luxury market.

Indeed, that "wealthiest 1%" we've been hearing so much about probably has helped drive up the value of middle-tier housing. As listings in established neighborhoods dwindle, Miller says, values in adjacent neighborhoods rise much faster. Lereah, of the realtors' association, notes appreciation for homes $500,000 and above in the second quarter topped 26% from a year earlier. "There have been a lot of millionaires being made in technology and just the stock market as a whole."

But just as the tech market has cooled, Miller notes that "we're not seeing the frenzy we were seeing six months ago." He anticipates prices will rise, but not as fast as in spring, owing in part to the Nasdaq correction. "We've had a long run, and I think people are being a little more cautious, but that's a relative term."

That goes even for some who might be in a position to splurge, like Darren Star, creator of such television programs as Beverly Hills 90210 and the soon-to-premiere The $treet . Though he would love to have a New York zip code to call his own, he said in a recent interview that he hasn't bought a Big Apple apartment and doesn't plan to anytime soon. Star blamed the inflated stock market, and the sense of a mania. "It's a troublesome time, and it drives up real-estate prices," he said.

Home prices overall in the New York metro area were running at a bit more sane pace, about 17% over the equilibrium price in the second quarter. But Lorraine Hunt-Kopacz, director of sales for Douglas Elliman in New Jersey, says that though growth is exploding in the horse-country communities of Bedminster and Basking Ridge 35 miles west of Manhattan, "prices have leveled a bit." She believes the peak came over the summer, with a slowdown starting toward the end of the season.

Upstate New York, by contrast, is in a veritable funk, with numerous markets like Rochester, Syracuse, Buffalo and Albany undervalued by as much as 23%. But in housing, as with stocks, cheap doesn't necessarily equate with a buying opportunity, at least for investment. Many upstate companies, such as Rochester's Eastman Kodak, are in a downsizing mode. One point of contention in the New York senatorial race between Hillary Rodham Clinton and Rick Lazio has been just how bad things really are in the region, and how much economic aid is needed.

Though job and population growth have been phenomenal in areas like Las Vegas, tight supplies have not been a problem, which has helped to keep home prices relatively in balance. But some areas, like Salt Lake City and Boise, Idaho, that benefited from the mid-1990s exodus of people from California looking for work or to escape from high taxes, are now surprisingly overvalued.

One former New Yorker moved to Boise about a year ago after using a spreadsheet to evaluate relocation options. Lisa Leff, who landed a position as a portfolio manager with Trillium Asset Management after she settled on moving out West, had a checkoff that included traditional quality-of-life categories like natural setting, culture and commuting time, as well as business infrastructure and affordability. "Whenever I got fed up with my life in Manhattan I took out my spreadsheet," says Leff. "Every time I scored them, Boise always came out on top." Her bosses at Trillium, a socially responsible investment adviser, initially were a bit skeptical about Boise. Idaho's image, says Leff, is "potatoes and the Aryan nation." Nonetheless, Leff says the Boise office is doing lots of business, and home prices have appreciated tremendously in the year she's lived there.

Other areas that picked up steam since the last time we looked were Madison, Wisconsin, which Winzer judges to be even more overvalued now, and Baltimore, which was fairly valued just a year ago but which saw an 18% increase in housing prices from 1998 to 1999.

Among the notable undervalued areas are Orlando and Tallahassee, Florida (the latter scores well in several surveys of the best metropolitan locations for small businesses), as well as President Clinton's former stomping grounds, Little Rock, Arkansas. In the Northeast, Philadelphia (where Jim Cuorato, director of commerce, is launching some high-tech initiatives) and Pittsburgh were among potential value opportunities.

Still, with the Nasdaq in a bear market, investors might look to Hong Kong as a sign of what can happen in overheated housing markets. This past summer, more than 2,000 homeowners marched in protest of property prices. Their beef: not that they were too high, but that they were still too low since the bubble burst starting in 1997 with the Asian financial crisis.

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